I’m the Washington D.C. bureau chief for Forbes and have worked in the bureau for more than two decades. I've spent much of that time reporting about taxes -- tax policy, tax planning, tax shelters and tax evasion. These days, I also edit the personal finance coverage in Forbes magazine and coordinate outside tax, retirement and personal finance contributors to Forbes.com. You can email me at jnovack@forbes.com and follow me on Twitter @janetnovack.

How Much Tax Will You Owe On $640 Million Jackpot?

The following story was updated at 1 p.m. on March 30th, to reflect the new, larger Mega Millions jackpot.

So let’s just say that you win the $540 $640 million Mega Millions jackp0t and are the only winner. (For the slim odds of that, check out this story.) How much of your winnings will you actually get to keep once Uncle Sam and your state take their cut? That depends on where you live; whether you claim your money now as a lump sum or take it as an annuity; and if you make the annuity choice, what happens to tax rates in the future.

Since we don’t know whether tax rates will go up, as scheduled, when the Bush era tax cuts expire at the end of 2012, let’s assume you are taking your money in a lump sum this calendar year. In that case, you’ll get only $389$462 million. (Yep, that higher $540$640 million figure is only if you’re ready to take your money over 26 years.)

Of the 42 states (plus the District of Columbia) participating in Mega Millions, five—New Hampshire, Tennessee, Texas, South Dakota and Washington —don’t have a state income tax. Should a resident of one of those states be the sole winner, he or she will have to fork over 35% to Uncle Sam —or $136 $161.7 million. (That 35% is the top rate on ordinary income, such as wages, and gambling winnings are taxed as ordinary income. Note: Some readers are confused by the fact that Mega Millions only withholds 25% federal tax. But I’m sorry to report that you still owe tax at the 35% rate.)

But if a New York City resident wins, he or she will get hit with the highest combined state and local tax in the nation— 8.82% will go to the state and another 3.87% to the city. State and local taxes are deductible from federal taxable income, which reduces the federal bite a bit. So the total federal/state/local tax bill for a New York City resident will come to about $168 $199.5 million, figures Bruce Cobern, a senior manager at accounting firm Crowe Horwath LLP in New York City.

Update: Readers have asked if a New York winner can simply move to a state without an income tax before claiming his or her prize and thereby escape the hefty New York tax. The answer is no. New York states in Publication 140-W that the winnings on any tickets bought in a lottery run by the New York State Division of Lottery—including Mega Million tickets purchased in New York State—are New York state source income, taxable by New York, whether you are a resident or not. If you bought the ticket in New York state, the state will take its cut out before paying you your winnings. New York City, however, does not have a tax on nonresidents. So if you aren’t a resident of the city and happen to buy your ticket while visiting the Big Apple, you won’t have to pay the extra 3.87%. What is unclear, according to Cobern, is whether a New York City resident who wins a big jackpot can move from the city, take annuity payments, and avoid the city tax on them—the city might assert that it still has a right to its cut, since the winner was a resident at the time of his big score.

(Additional update/correction: In my original story, I wrote that a California resident would be subject to a 10.3% tax. That is incorrect. As a reader pointed out, California actually exempts state lottery winnings from its income tax. So does Pennsylvania. So that make seven states—the five without a state income tax, plus the two that exempt lottery winnings—where there is no state tax due. As other readers pointed out, Delaware used to exempt lottery winnings, but changed its law and taxes jackpots won after 2009–although the Mega Millions site does not reflect that fact.)

If you plan to share your good fortune with your family, beware the federal gift and estate tax. Under current law, any amount over $5.12 million you give to recipients other than a spouse is subject to a 35% federal gift or estate tax. The $5.12 million is a unified gift/estate tax exemption, meaning what you give away now reduces the amount you can pass on tax free at death. If you’re married, you and your spouse can pool exemptions and give away a combined $10.24 million tax free during your lives or at death. But be forewarned: the current gift/estate law expires at the end of this year and unless Congress acts, the estate and gift tax exemption will fall to a measly $1 million. So if you win, you might want to make gifts quickly. (Note: You can make annual tax-free gifts of up to $13,000 to as many individuals as you want, without it counting against your exemption.)

Fortunately, most states don’t have gift taxes. But 22 states and the District of Columbia do impose inheritance or estate taxes. So if you live in one of them, giving away money to your family while you’re alive could save a tidy amount in state estate tax. (For state death tax rates, see the map here.)

What if you plan to give a big chunk of your winnings to charity? Do it this year, at the same time you’re recognizing income. You can deduct your whole cash gift from your taxable income, but if you wait until later years to give, you may not have enough income to deduct your gifts against. Or, if you’re serious about becoming a philanthropist, take the payout over 26 years and donate over time, as you build up expertise and experience with the causes and charities you’re funding—the way billionaire Microsoft founder Bill Gates and his wife Melinda have done.

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Interesting article. I have a scenario for your consideration.. what happens if a US citizen – Puerto Rico resident wins this.? Since this loterry is not available in PR the individal will have to play when travelling which as far I know is allowed to do, but that US citizen that reside in Puerto Rico do not pay Federal Taxes in Puerto Rico. Since PR lottery winnings are taxed in Puerto Rico, either by income increase or loterry tax most likely PR goverment will take a chunck but what happens with the rest (Federal Tax & State tax of where the ticket was adquired)?

If you buy the ticket in New York, the state will tax your winnings whether you are a resident of New York or not. So I suggest you buy your Mega Millions tickets in the future in a U.S. state that doesn’t have an income tax or doesn’t tax lottery winnings. (For example, California doesn’t) The New York publication setting out its policy is here.

and Federal taxes – the big one? Do they work the same way -like the state taxes that they go according where you adquired the tickets. Since all states pays federal taxes it does not really matter since it will not make a diference but since PR residents does not pay federal taxes what will happen there? Do Uncle Sam have a rule for that situation?

I can’t answer how every state does it. But I can tell you that New York explains in publication 140-W (link here that the winnings on any tickets bought in a lottery run by the New York State Division of Lottery—including Mega Million tickets purchased in New York State—are New York source income, taxable by New York whether you are a resident or not! So you can’t escape the New York tax by moving before you cash in your ticket. Nor can you escape the tax by moving and taking payment in the form of an annuity. New York will withhold its share before paying you. That means, for example, if you’re a Pennsylvania resident who works in New York (as some do)m you should never buy your tickets at work. Instead, buy them at your home in Pennsylvania—Pennsylvania doesn’t tax lottery winnings.